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Car buying can be a stressful experience for a number of reasons. Figuring out what you need in a vehicle in terms of specs and features is challenging enough. When you throw in how much you can reasonably afford, you may find yourself pulling your hair out.
The main challenge for many car buyers is knowing how much you should budget to prevent yourself from getting into a deep financial hole. There isn’t a magical number or percentage for this budget since it depends on an individual’s financial status. So, instead of giving you one answer to this challenging question, here are six.
The Bare Minimum
Nothing says you have to spend a lot of money on a car. You can find a decent vehicle (especially used) at nearly any price. There are some price points that are mostly filled with obvious junkers and potential lemons, but it might be worth setting a minimum budget and then working upward.
Finding that minimum is a balancing act between keeping the price low and still getting a decent car. This is why you should do some research ahead of time. Look at what cars (types and conditions) are available at different price points. If you start to see vehicles that are okay (perhaps not ideal) candidates, and the price is still below what you are willing to spend, you have reached the minimum point.
The Right “Dent” on Your Total Income
Affording large purchase items like cars and houses obviously depends on how much money you have or make, but it isn’t as simple as having more money than the price tag of the item. A car’s affordability depends on how much you make in relation to your other expenses.
You should think about the price of a vehicle in relation to your income as a percentage. You can do this for your monthly income, but it helps to start with your overall income first. This way, you will know exactly how much of a dent a new car will make on your financial security.
Some experts suggest specific ratios (i.e. no more than 10% of your monthly income), but this doesn’t take into account what other expenses drain your income. Instead, you have to look at everything in relation to each other.
On a yearly basis, for example, how much of your income is taken up by the house, food, or other expenses? How much does that leave for a car? Do you want to save some more of the leftover money for general or fun expenses? Depending on your answers, figure out how much of a dent feels okay to you. If the dent is too large, you’ll need to look for a cheaper car.
The Right Monthly Car Payment Amount
One way to think about the cost of a car in relation to your income is to break it down by the month. After all, most things you purchase are paid on a monthly basis. Have a monthly house payment? Insurance premiums? Family expenses? All of these things take a chunk of your monthly income. A car payment will just be another thing to add to the monthly budget.
Like the big picture dent on your total income, you should have a monthly car payment that fits with your other expenses while ideally leaving some money to save or spend on “wants” instead of “needs.” In general, the lower the car payment is, the better. If the car payment is more than a home loan, you’ve probably gone too high.
Also, keep in mind the time component: the amount of time it will take to pay off the car. If you have a five-year loan (with the extra interest), for example, this means 60 months of your income will be affected.
Whatever the length of time you choose, be certain that you’re capable and comfortable paying off that amount each month for that long, in addition to other expenses like car insurance, credit card debt, and daily costs. Your monthly take-home pay will help you gauge if things are going to be too tight.
Less with an Auto Loan
The way you pay for a car can affect how much you can actually afford. Car loans, for example, increase the cost of a vehicle because of the interest: the extra amount the lender makes when lending you the money. This interest rate will depend on the value of the new or used car, your credit score (and possibly your take-home pay), the loan term, the desired loan payment amount, and the individual lender or dealership.
It’s important to keep this in mind when determining the amount you can afford. Consider the down payment you will make, the trade-in value of an old vehicle, the sales tax, and the loan amount itself.
If you set a budget and start looking at vehicles, you’ll have to look at lower price tags to stay under the limit because of the interest. The particulars of the interest rate combined with the cost of the vehicle will ultimately tell you how much extra you will be spending once the loan is paid off.
Slightly More with a Lease
Leasing tends to be the preferred payment option when you aren’t expecting to keep a new vehicle for the next five to ten years. In some ways, leasing is for people who like to trade in cars frequently for the next best thing.
When it comes to how much you can spend on a car, leasing may also be a preferable option since monthly payments tend to be lower. During the lease, you won’t pay the total price of the vehicle like you would with a loan, so you can look at vehicles that are closer in price to your maximum limit.
It’s still important, however, to know how much you will be paying per month with a lease to make sure the amount is comfortable and doable.
More with Cash
Paying in cash doesn’t mean you can magically afford an expensive car. If you have a budget, stick with it. Instead, paying in cash means you don’t have to factor in the interest you’d be paying with a loan.
In other words: Car loans increase the price overall, whereas cash purchases are usually for just the amount of the car (plus fees and taxes). This means you can safely use the price tag of a vehicle alone when determining if the cost is going to be manageable and doable with your current finances.